Opening a sub-account with FII's

Since 2004 most of the foreign hedge funds who were not resisted
in India as FII's were investing in the Indian stock market
indirectly by opening a sub-account with FII's already
registered in India. Participatory notes were issued by foreign
institutional investors (FIIs) registered in India to
unregistered overseas investors, including hedge funds.
Registered FIIs buy Indian securities and issue the notes based
on the underlying asset.

The 2004 regulation on FIIs had given five-year time-frame for
the offshore derivative instruments including participatory
notes, equity linked instruments and other such instruments
backed by underlying listed equities. That appeared like a
facilitating move to help easy entry, rather than legitimize the
anonymity of investors behind a vague instrument.

In October 2007, India's
stock market regulator (SEBI) has tightened investment rules for
unregistered foreigners by clamping down on issuance of indirect
investment notes to stem inflows of anonymous money. click here for New FII Rules

FIIs and their sub-accounts -- vehicles set up by registered
FIIs to issue P-notes -- are no longer allowed to issue P-notes
whose underlying asset is a derivative.

The regulator has
also ordered to wind up the current derivatives-based
Participatory Notes in 18 months from October 2007.

The move is aimed at
alerting the overseas hedge funds that they should get
themselves registered as FIIs before the sunset clause expires
while continuing to invest.

In a nutshell, the sub-accounts of FIIs (foreign
institutional investors) are required to be registered as FII's.
SEBI (the Securities and Exchange Board of India) has announced
a deadline for letter of intent from proprietary sub-accounts
wishing to apply for FII status. And a week’s time was given for
submitting application. Sub-accounts, are the mechanism
through which FIIs handle PNs (participatory notes).

Market regulator Security Exchange Board of India
recenlty announced new rules for foreign investments
through financial instruments such as participatory notes,
asking FIIs to wind up P-Notes for investing in
derivatives within 18 months.

SEBI also imposing curbs on P-Notes for investing in spot
market.

In derivatives, foreign institutional investors (FIIs) and
their sub-accounts cannot issue fresh P-Notes and will
have to wind up their current position in 18 months.

In spot market, FIIs will not be allowed to issue P-Notes
more than 40 per cent of their assets under custody. The
reference date for calculating such assets will be
September 30.

Those FIIs who have issued P-Notes of more than 40 per
cent of their assets could issue such instruments only if
they cancel, redeem, or close their existing PNs. Those
FIIs who have issued P-Notes less than 40 per cent of
their assets under custody can issue additional
instruments at the rate of 5 per cent of their assets.

Highlights of New Rules

No dilution of know-your-customers norms for
registration of FIIs to prevent money laundering

FIIs to be registered on a permanent basis instead
of earlier practice of renewing registration every three
years

Hedge funds are
generally funds managing funds for private investors
and also collect a part of the profit, beside a management fee
from the investors.

Mostly prevalent in
developed markets like the US, these funds are generally used by
wealthy individuals and institutions, adopt aggressive
investment strategies and are exempt from rules and regulations
governing other mutual funds provided the number of investors is
not more than 100.

What are P-notes?
P-Notes are instruments like contract notes issued by FIIs to overseas
investors who cannot directly invest in equity market as they are not
registered.

Q1. Who is a Foreign Institutional Investor (FII)?

Ans. FII means an entity established or
incorporated outside India which proposes to make investment in
India.

Q2. What is a sub-account?

Ans. Sub-account includes those foreign
corporations, foreign individuals, and institutions, funds or
portfolios established or incorporated outside India on whose
behalf investments are proposed to be made in India by a FII.

Q3. What is a Designated Bank?

Ans. Designated Bank means any bank in India
which has been authorized by the Reserve Bank of India to act as
a banker to FII.

Q4. Who is a Domestic Custodian?

Ans. Domestic Custodian means any entity
registered with SEBI to carry on the activity of providing
custodial services in respect of securities.

Q5. What is a Broad Based Fund?

Ans. Broad Based Fund means a fund established
or incorporated outside India, which has at least twenty
investors with no single individual investor holding more than
10% shares or units of the fund.

Provided that if the fund has institutional
investor(s) it shall not be necessary for the fund to have
twenty investors.

Provided further that if the fund has an
institutional investor holding more than 10% of shares or units
in the fund, then the institutional investor must itself be
broad based fund.

FII REGISTRATION

Q6. Who can get registered as FII?

Ans. Following entities / funds are eligible to
get registered as FII:

Pension Funds

Mutual Funds

Insurance Companies

Investment Trusts

Banks

University Funds

Endowments

Foundations

Charitable Trusts / Charitable Societies

Further, following entities proposing to invest
on behalf of broad based funds, are also eligible to be
registered as FIIs:

Asset Management Companies

Institutional Portfolio Managers

Trustees

Power of Attorney Holders

Q7. What are the parameters on which SEBI
decides FII applicants’ eligibility?

Ans.

Applicant’s track record, professional
competence, financial soundness, experience, general
reputation of fairness and integrity. (The applicant should
have been in existence for at least one year)

whether the applicant is registered with and
regulated by an appropriate Foreign Regulatory Authority in
the same capacity in which the application is filed with
SEBI

Whether the applicant is a fit & proper
person.

Q8. Which form needs to be filled in when
applying for FII registration?

Ans. "Form A" as prescribed in SEBI (FII)
Regulations, 1995.

Q9. Which documents need to be sent with
"Form A"?

Ans.

Certified copy of relevant clauses (clauses
permitting the stated activities) of Memorandum of
Association, Article of Association or Article of
Incorporation.

Audited financial statement and annual
report for the last one year (period covered should not be
less than twelve months

Q10. How much is the fee for registration as
FII?

Ans. US $ 5,000.

Q11. When is the registration fee payable?

Ans. At the time of submitting the application
for registration.

Q12. What is the mode of payment?

Ans. Demand Draft in favour of "Securities and
Exchange Board of India" payable at New York

Q13. How many days it takes to get registered
as FII?

Ans. SEBI generally takes seven working days in
granting FII registration. However, in cases where the
information furnished by the applicants is incomplete, seven
days shall be counted from the days when all necessary
information sought, reaches SEBI.

In cases where the applicant is bank and
subsidiary of a bank, SEBI seeks comments from the Reserve Bank
of India (RBI). In such cases, 7 working days would be counted
from the day no objection is received from RBI.

Q14. What is the registration process for FII?

Ans. Please contact us for registration.

Q15. What is the validity period of FII
registration?

Ans. The FII registration is valid for 5 years.
After expiry of 5 years, the registration needs to be renewed.

Q16. What is the process of renewal?

Ans. Same as initial registration. Along with
"Form A" and all the relevant documents, the applicants are
required to fill in additional form (Annexure 1) while applying
for renewal.

Q17. Is there any renewal fee?

Ans. Yes, US $ 5,000 needs to be paid for
renewal of FII registration.

Q18. When the application for renewal should
be submitted

Ans. Three months before expiry of the FII
registration.

Q19. What are 100 % debt FIIs/sub-accounts,
and what is the process for their registration?

Ans. 100 % debt FIIs are debt dedicated FIIs
which invest in debt securities only. The procedure for
registration of FII/sub-account, under 100% debt route is
similar to that of normal funds besides a clear statement by the
applicant that it wishes to be registered as FII/sub-account
under 100% debt route.

Note: In case the applicant is a
‘Bank’ or "Subsidiary of a Bank" then the application form and
relevant documents need to be submitted in duplicates.

SUB-ACCOUNT REGISTRATION

Q21. Who can get registered as sub-account?

Ans.

Institution or funds or portfolios
established outside India, whether incorporated or not.

Proprietary fund of FII.

Foreign Corporates

Foreign Individuals

Q22. Who need to apply for sub-account
registration?

Ans. The FII should apply on the behalf of the
Sub-account. Both the FII and the Sub-account are required to
sign the Sub-account application form.

Q23. Which form needs to be filled when
applying for sub-account registration?

Ans. "Annexure B" to "Form A" (FII application
form).

Q24. What documents need to be sent with
Annexure A?

Ans. None

Q25. How much is the fee for sub-account
registration?

Ans. US $ 1,000

Q26. When is the registration fee payable?

Ans. At the time of submitting the application.

Q27. What is the mode of payment?

Ans. Demand Draft in the name of "Securities and
Exchange Board of India" payable at New York

Q28. How many days it takes to get a
sub-account registered?

Ans. SEBI generally takes three working days in
granting FII registration. However, in cases where the
information furnished by the applicants is incomplete, three
days shall be counted from the days when all necessary
information sought, reaches SEBI.

Q29. What is the validity period of
sub-account registration?

Ans. The validity of sub-account registration is
co-terminus with the FII registration under which it is
registered.

Q30. What is the process of renewal of
sub-account?

Ans. Same as initial registration.

Q31. Is there renewal fee?

Ans. Yes, US $ 1,000

Q32. Can OCBs / NRIs permitted to get
registered as FII/sub-account?

Ans. No, they are not permitted.

POST-REGISTRATION PROCESSES

Q33. What is the procedure in case the FII/sub-account
changes its name?

Ans. If a registered FII/sub-account undergoes
name change, then the FII need to promptly inform SEBI about the
change. It should also mention the reasons for the name change
and give an undertaking that there has been no change in
beneficiary ownership.

In case of name change of FII, the request
should be accompanied with documents from home regulator and
registrar of the company evidencing approval of name change, and
the original FII registration certificate issued by SEBI should
be sent back for necessary amendment.

Q34. What is the procedure for transferring a
sub-account from one FII to another?

Ans. The FII to whom the Sub-account is proposed
to be transferred has to send a request along with a declaration
that it is authorized to invest on behalf of the Sub-account.
The transferor FII should also submit a No-objection
certificate.

Q35. What is the procedure for change of
domestic custodian?

Ans. The FII should send a request, along with
no-objection certificate from existing domestic custodian, for
change in domestic custodian.

Q36. Can FII/sub-account registration be
cancelled on request?

Ans. Yes, the FII would be required to send a
request for cancellation of its registration or registration of
its Sub-account/s clearly mentioning the name and registration
number of the entity. The FII should ensure that it /
Sub-account has nil cash / securities holdings.

Q37. What if the FII does not renew
its/sub-account’s registration?

Ans. The registration of the FII / Sub-account
would get expired at due date and it would not be allowed to
trade in Indian securities markets. If it is not interested in
renewal but has certain residual assets, it can apply for
disinvestment in terms of
Circular No. FITTC/CUST/12/2001 dated June 04, 2001 and
abide by the guidelines specified in this regard.

INVESTMENT OPPORTUNITIES

Q38. Which financial instruments are
available for FII investments?

Ans.

Securities in primary and secondary markets
including shares, debentures and warrants of companies,
unlisted, listed or to be listed on a recognized stock
exchange in India;

Units of mutual funds;

Dated Government Securities;

Derivatives traded on a recognized stock
exchange;

Commercial papers.

Q39. What are the investment limits on equity
investments by FII/sub-account?

Ans.

FII, on its own behalf, shall not invest in
equity more than 10% of total issued capital of an Indian
company.

Investment on behalf of each sub-account
shall not exceed 10% of total issued capital of an India
company.

For the sub-account registered under Foreign
Companies/Individual category, the investment limit is fixed
at 5% of issued capital.

These limits are within overall limit of 24% /
49 % / or the sectoral caps a prescribed by Government of India
/ Reserve Bank of India.

Q40. What are the investment limits on debt
investments by FII/sub-account?

Ans. The FII investments in debt securities are
governed by the policy if the Government of India. Currently
following limits are in effect:

For FII investments in Government debt,
currently following limits are applicable:

100 % Debt Route

US $ 1.55 billion

70 : 30 Route

US $ 200 million

Total Limit

US $ 1.75 billion

For corporate debt the investment limit is
fixed at US $ 500 million.

Q41. What other investment limits are there?

Ans.

Normal FII (70:30 Route)

100% Debt FII

Total investment in equity and equity
related instruments shall not be less than 70% of aggregate
of all investments.

100% investment shall be made in debt
security only.

Q42. In whose name should the securities be
registered?

Ans.

In the name of FII when making investments
on its own behalf

In the name of sub-account when making
investments on behalf of Sub-account

In the name of "FII a/c sub-account" when
making investments on behalf of Sub-account.

DERIVATIVES POSITION LIMITS

Q43. What are the restrictions on investment
in derivatives?

Ans.

The FII position limits in a derivative
contracts (Individual Stocks)

The FII position limits in a derivative
contract on a particular underlying stock i.e. stock option
contracts and single stock futures contracts are:

For stocks in which the market wide
position limit is less than or equal to Rs. 250 Cr, the
FII position limit in such stock shall be 20% of the
market wide limit.

For stocks in which the market wide
position limit is greater than Rs. 250 Cr, the FII
position limit in such stock shall be Rs. 50 Cr.

FII Position limits in Index options
contracts

FII position limit in all index options
contracts on a particular underlying index shall be Rs. 250
Crore or 15 % of the total open interest of the market in
index options, whichever is higher, per exchange.

This limit would be applicable on open
positions in all option contracts on a particular underlying
index.

FII Position limits in Index futures
contracts:

FII position limit in all index futures
contracts on a particular underlying index shall be Rs. 250
Crore or 15 % of the total open interest of the market in
index futures, whichever is higher, per exchange.

This limit would be applicable on open
positions in all futures contracts on a particular underlying
index.

In addition to the above, FIIs shall take
exposure in equity index derivatives subject to the following
limits:

Short positions in index derivatives
(short futures, short calls and long puts) not exceeding
(in notional value) the FII’s holding of stocks.

Long positions in index derivatives
(long futures, long calls and short puts) not exceeding
(in notional value) the FII’s holding of cash,
government securities, T-Bills and similar instruments.

FII Position Limits in Interest rate
derivative contracts

At the level of the FII

The notional value of gross open position of a
FII in exchange traded interest rate derivative contracts
shall be:

US $ 100 million.

In addition to the above, the FII may take
exposure in exchange traded in interest rate derivative
contracts to the extent of the book value of their cash
market exposure in Government Securities.

At the level of the sub-account

The position limits for a Sub-account in near
month exchange traded interest rate derivative contracts shall
be higher of:

Rs. 100 Cr

or

15% of total open interest in the market
in exchange traded interest rate derivative contracts.

Ans. Yes, FII/sub-account may issue, deal in or
hold off-shore derivative instruments such as Participatory
Notes, Equity Linked Notes or any other similar instruments
against underlying securities, listed or proposed to be listed
on any stock exchange in India.

Q45. Who can subscribe to/invest in
Participatory Notes?

Ans.

Any entity incorporated in a jurisdiction
that requires filing of constitutional and/or other
documents with a registrar of companies or comparable
regulatory agency or body under the applicable companies
legislation in that jurisdiction;

Any entity that is regulated, authorised or
supervised by a central bank, such as the Bank of England,
the Federal Reserve, the Hong Kong Monetary Authority, the
Monetary Authority of Singapore or any other similar body
provided that the entity must not only be authorised but
also be regulated by the aforesaid regulatory bodies;

Any entity that is regulated, authorised or
supervised by a securities or futures commission, such as
the Financial Services Authority (UK), the Securities and
Exchange Commission (Sub-account), the Commodities Futures
Trading Commission (Sub-account), the Securities and Futures
Commission (Hong Kong or Taiwan), Australian Securities and
Investments Commission (Australia) or other securities or
futures authority or commission in any country , state or
territory ;

Any entity that is a member of securities or
futures exchanges such as the New York Stock Exchange
(Sub-account), London Stock Exchange (UK), Tokyo Stock
Exchange (Japan), NASD (Sub-account) or other similar
self-regulatory securities or futures authority or
commission within any country, state or territory provided
that the aforesaid mentioned organizations which are in the
nature of self regulatory organizations are ultimately
accountable to the respective securities / financial market
regulators.

Any individual or entity (such as fund,
trust, collective investment scheme, Investment Company or
limited partnership) whose investment advisory function is
managed by an entity satisfying the criteria of (a), (b),
(c) or (d) above.

Q46. What are the reporting Requirements for
the FII / Sub-account issuing

Participatory Notes?

Ans.

FII/sub-account who
issue/renew/cancel/redeem PNs, require to report on Monthly
basis. The report should reach SEBI by the 7th day of the
following month.

The FII/sub-account merely
investing/subscribing in/to the Participatory Notes/Access
Products/Offshore Derivative Instruments or any such type of
instruments/securities with underlying Indian market
securities are required to report on quarterly basis
(Jan-Mar, Apr-Jun, Jul-Sep and Oct-Dec).

FIIs/sub-accounts who do not issue PNs but
have trades/holds Indian securities during the reporting
quarter (Jan-Mar, Apr-Jun, Jul-Sep and Oct-Dec) require to
submit 'Nil' undertaking on a quarterly basis.

FIIs/sub-accounts who do not issue PNs and
do not have trades/ holdings in Indian securities during the
reporting quarter. (Jan-Mar, Apr-Jun, Jul-Sep and Oct-Dec):
No reports required for that reporting quarter.

Q47. How to send report on Participatory
Notes?

Ans.

The format for reporting on issuance/
renewal / redemption of the Participatory Notes is
prescribed as per "Annexure B" in our Circular No. IMD/CUST/15/2004
dated April 02, 2004 [

The reports should be e-mailed only to SEBI

In case of Nil-reports, ‘Annexure B’ is not
required. Instead the FII on behalf of its Sub-account
should submit the undertaking prescribed in our circular No.
IMD/CUST/9/2003 dated November 20 , 2003